I’m the Washington D.C. bureau chief for Forbes and have worked in the bureau for more than two decades. I've spent much of that time reporting about taxes -- tax policy, tax planning, tax shelters and tax evasion. These days, I also edit the personal finance coverage in Forbes magazine and coordinate outside tax, retirement and personal finance contributors to Forbes.com. You can email me at jnovack@forbes.com and follow me on Twitter @janetnovack.

IRS Advocate: New Taxpayer Rights Crisis Is Brewing

Taxpayers win when government agencies are asked to do more with less, right? Not when the agency in question is the Internal Revenue Service, says National Taxpayer Advocate Nina E. Olson.

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In her annual report to Congress released today, Olson asserts the most serious problem facing taxpayers today is that Congress is asking the IRS to administer an ever more complicated and constantly changing tax code, including a growing number of refundable tax credits, with a too small and now shrinking budget. That’s led to a decline in taxpayer service and has increased both the opportunities for refund tax fraud and the IRS’ reliance on automated systems to fight refund fraud and other noncompliance—which is putting honest taxpayers’ rights and interests at risk.

While these trends aren’t new, “we’re at a tipping point,” Olson said today in an interview. For fiscal 2012, the IRS’ budget has been cut 2.5% and with pressure on to contain the deficit, more cuts seem possible. Moreover, the IRS is under pressure to narrow the “tax gap”—just last week the IRS estimated that taxpayers failed to voluntarily pay $450 billion (17%) of what they owed in 2006, and that even after all its enforcement efforts, there was still a $385 billion net tax gap for 2006. There’s been some talk recently of getting the IRS extra funding (not subject to budget caps) for enforcement under a special “program integrity” exemption. Those with long memories (or an interest in how the pendulum swings) might recall that similar pressures to close the tax gap led to alleged systemic rights abuses by the IRS in the 1990s and the IRS Restructuring and Reform Act of 1998, which expanded taxpayer protections and improved service but also hobbled IRS enforcement for years, emboldening tax shelter promoters and other cheats. (For more on the aftermath of the 1998 law, see Are You A Chump? )

“We’ve had a number of years where the trending of taxpayer service funding has gone down and down in contrast to the increase of enforcement funding. And then when you layer on the budget constraints, what you see is that taxpayer service is going to decline even more,’’ Olson said. Add to that the deficit driven pressure for revenue collection and “historically, that is where the IRS gets into trouble,’’ she observed.

In a statement today, the IRS summarily dismissed Olson’s warnings. “While today’s report includes a number of helpful suggestions, the link described in the report between a challenging budget environment and alleged erosions in taxpayer rights is inaccurate and without basis in fact,’’ IRS spokeswoman Michelle Eldridge said in a statement.

Olson, whose staff works within the IRS to resolve taxpayers’ problems, can’t be fired by the IRS Commissioner and is known for being one of Washington’s most outspoken officials. Still, her new report and her comments to Forbes seem stronger and more urgent than her past statements. “I’m trying to give a warning to everybody, if we continue down this road, bad things are going to happen to taxpayers and it will be very difficult to reverse. We have been here before. We don’t need to go down this road again,” Olson explained. “The IRS workforce is being told `produce, produce, produce and treat people like widgets.’ When IRS employees start seeing that machines are valued and personal interaction isn’t valued, why should they listen a little longer to that taxpayer? That is the abuse that happened in 1995, 1996, and 1997, that the message to front line employees was `get the next case out and don’t engage with taxpayers,’ which meant you got wrong answers and taxpayers would get furious and that lead to overreaching on both parts.”

Here are some of the worrisome signs Olson sees.

Reliance on correspondence exams. Of the 1.56 million individual audits the IRS conducted in fiscal 2011, 1.17 million were so-called “correspondence” exams. Typically, taxpayers are sent a letter saying some deductions, say for charity or unreimbursed employee business expenses, or some credit will be disallowed unless they submit adequate documentation substantiating that deduction or credit within 30 days. The letter taxpayers receive gives them a toll free number to call with questions, but not the name of a specific person to contact at the IRS. Half of correspondence audits are concluded with no personal contact with the IRS whatsoever. Moreover, the IRS’ correspondence backlog (see below), means some taxpayers end up being assessed extra tax simply because the IRS hasn’t processed their responses in time. Correspondence audits are also notoriously poor at discovering unreported income (as opposed to inflated deductions), the largest part of the tax gap.

A swelling backlog of unresolved letters from taxpayers. In the last week of FY 2011, Olson reports, the IRS had an inventory of 920,768 letters, up from 357,151 in the last week of FY 2004. Even more troubling, 47% of the 2011 letter inventory was “over-age,’’ compared to just 11.5% in 2004—meaning the cache of old letters had increased tenfold to more than 430,000 in 2011. (Correspondence is considered over-age if the IRS has had it for 45 days or more and the issue it deals with has not been resolved.) “The implications of that are huge. Taxpayers are writing in saying `I disagree with your adjustment’ or `Here’s my document for the following’ or `I want an installment agreement’ and those things are sitting on a wall somewhere not associated with the case,’’ Olson said. “It’s not in the hands of a human being. It’s all on automated processes. You hear this from practitioners a lot, how frustrated they are with correspondence exams, because they send in documentation and the next communication is a notice of deficiency because the documentation is sitting on a wall somewhere and hasn’t been connected up with a case. The machine issues the notice of deficiency. There’s no human being there.”

(Cuppertino, Cal. tax pro Claudia A. Hill, who edits Forbes’ IRS Watch blog as well as CCH’s Journal of Tax Practice and Procedure, notes that while the IRS letters don’t say so, a taxpayer can request more than 30 days to respond to a correspondence exam document request. “Currently, IRS is so backlogged that they are actually permitting a longer response time,” she said in an email–if that is, the taxpayer knows enough to ask for more time.)

Declining taxpayer phone service. Only 70% of calls to the IRS in which the caller sought to speak to a human were completed in fiscal 2011, down from a high of 87% in 2004. (The other 30% of callers either got a busy signal or got tired of being on hold and hung up.)

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And, go to a territorial taxation system so as to be competitive with other exporting nations who unlike the US, do not tax their citizens income who reside in another counter.

The current US jihad against expat foreign accounts via the VDPs is making it extremely difficult for a shrinking US diaspora, (not counting those troops scattered around the world) as more decide the expense and complexity of keeping up with foreign tax compliance and reporting and resulting double taxation makes returning to Kansas seem inviting. :) Or, sadly, just renounce their US citizenship to shed the burden.

A totally-correct recommendation. The US has a massive $720 billion trade deficit, while Germany which is just one example of many among the high-wage industrialized nations, has a $198 billion job-creating trade surpuls and a healthy trade surplus with China as well. How does Germany do it? They encourage their citiens to relocate abroad and sell their high-priced exports which they do with great success, and consider them patriots. Their foreign income is not taxed by Germany. The US does just the opposite: It subjects its citizens who relocate abroad to double taxation so they will stay home and considers any who go as tax evading traitors. That is why the US has a $720 billion trade surplus while Germany has a $198 billion trade surplus AND the lowest unemployment rate in 20 years. You sow what you reap. Feet on the ground = trade surpluses. No feet on the ground = trade deficits. It is just that simple but nobody in Washington, either on Capitol Hill or Pennsylvania Avenue seems to really care.

It is not that easy to renounce your US citizenship and to shed you US tax obligations. If you are worth more than $2 million, you are expected to file a final US tax return when your “divorce” is approved that assumes that you disposed of all of your assets and to pay all capital gains taxes that would be due on a deemed disposition. Even expats who moved to a foreign country with their parents when they were babies may one day find themselves on a list of Americans barred from re-entry (or worse) because they failed to file US tax returns.

Rocky, Not only does the situation you describe apply to expats born in the US who moved to a foreign country with their parents, it also applies to persons born abroad to 1 US parent. Even though they may have never in their lives even visited the US and although they don’t know a word of English, they are US citizens and as such subject to US tax laws in the same way that a person who is born in Peoria who has never been out of Illinois is subject to US taxation. If the person’s income is $9,350 or its equivalent in foreign currency that person must file US tax returns. And it is illegal for US citizens to enter the US using a foreign passport even though a dual citizen of another country. There are many US citizens in this category who could be in big trouble if they ever enter the US. The penalty for failing to file a US tax return is $10,000 for each year, for up to 8 years an

And the IRS will insure that such a person who enters the US is not permitted to leave until this penalty is paid. Most of these people have no idea they are US citizens, but ignorance of the law is not an acceptable excuse to the IRS. There are also even more severe penalties for failing to file FBAR reports if the person has a foreign bank account the value of which exceded $10,000 on any day during the year, or had signature authority over such an account even though the funds are not his, but are those of an employer or other person. Next Year FATCA reports will also have to be filed. The final report form still has not been finalized, but it is a real monster.

rogerc is absolutely correct. Knowledgeable employees of a company sell their products and face-to-face customer contact is crucial. Living and working in the off-shore markets selling U.S. made products has proven to be successful. Double taxation destroyed that relationship and trade deficits resulted.

A very good article on a situation that is impacting Americans at home and abroad. Right now there are IRS offices in Paris, London, Beijing and Frankfurt and they do try but their services are limited: http://www.irs.gov/localcontacts/article/0,,id=101292,00.html

If the IRS enforcement efforts are successful and more and more Americans abroad try to file and get compliant, these offices will need to expand their services and greatly increase their staff with people who not only understand the U.S. tax system but the foreign tax and financials systems too (27 of them in the EU alone). This was recognized in the 2011 Taxpayer Advocate Report to Congress here: http://www.irs.gov/pub/irs-utl/2011_arc_internationalmsps.pdf

Here is what they say:

“The complexity of international tax law, combined with the administrative burden placed on these taxpayers, creates an environment where taxpayers who are trying their best to comply simply cannot. For some, this means paying more U.S. tax than is legally required, while others may be subject to steep civil and criminal penalties. For some U.S taxpayers abroad, the tax requirements are so confusing and the compliance burden so great that they give up their U.S. citizenship.

A recent IRS study of taxpayer needs and preferences showed that international taxpayers may have a greater current need for IRS services than the general taxpayer population.”

As an American citizen who lives abroad I can personally attest to the accuracy of this. Without help it is almost impossible to be compliant.

I am personally “caught” in this log jam. I have been audited for an energy credit which I qualified and took in 2009. They are now disallowing the deduction because the merchant I chose to install my HVAC system refuses to provide a breakdown of the actual cost minus the cost of installation. And, of course, I am now faced with the $1500 energy credit plus compounded interest — some $2000 and ticking. I received correspondence which states I can contact the person shown at the top of the letter; unfortunately the “Person to Contact: CORRESPONDENCE EXAM TECHNICIAN AT 1-866-897-0161.” Yes, I am most certainly caught up in this crisis. When I call, I am placed on hold and sometimes my call is disconnected. I did however finally speak to someone who stated she was not the person assigned to my case. She documented my concern and advised she would have the person assigned return my call. I am still waiting for the call!!

Unfortunately my experience with the Taxpayer Advocate has been less than satisfying. The IRS in person or on the phone is a long slow process that requires mountains of patience, the ability to repeatedly present your case with documentation, and hours of waiting on hold or in person.